Analyst: Look for Zynga to Profitably Grow Business

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

The Wedbush Investment Committee is adding Zynga (NASDAQ:ZNGA) to the Best Ideas List.

We expect Zynga to meet or exceed first-quarter guidance and reiterate full-year guidance when it reports results on April 23. We expect to publish a preview note with our final view on the quarter ahead of that date. Our Q1 estimates are for bookings of $150 million and earnings per share of 0 cents, versus consensus of $148 million and 1 cent, and guidance of $138 million-$148 million and 1 cent. We believe management has undertaken an “under-promise and over-deliver” approach to guidance, strengthening our belief that it will avoid a miss. Our FY estimates are for bookings of $820 million and EPS of 4 cents, versus consensus of $788 million and 1 cent, and guidance of $760 million-$810 million and 1 cent-3 cents.

Zynga appears determined to address the “play anywhere” free-to-play market by leading with mobile games and ensuring that its games are available cross-platform. The company recently updated its Words with Friends and Zynga Poker games on mobile, and it has entered limited beta testing of its FarmVille 2 mobile version. Ultimately, we expect Zynga to lead with a mobile-first strategy and to ensure that all of its games are playable on mobile, tablet, and PC.

Zynga management is focused on the top 20 mobile markets and intends to focus its new games on the highest-revenue genres in those markets. Management has focused Zynga’s development on 15 genres common to the top 20 markets globally, positioning the company to capture share and grow revenues.

We expect Zynga to profitably grow its business. Management sounds confident that Zynga can hit its bookings and profitability goals, and we expect to see regular increases in guidance as the company continues to execute on its strategy. We believe that over 30 percent contribution margins are achievable over the long run, as Zynga sees revenues grow beyond the $1 billion level again.

We think that Zynga’s current staffing levels imply that a significant number of new products are on the horizon. The company has approximately 2,000 employees, including 260 hired as part of the NaturalMotion acquisition. This figure is down from 3,400 employees at its peak and reflects approximately 1,000 employees working on existing franchise and the balance working on new projects.

Maintaining OUTPERFORM rating and 12-month price of $7. Our PT reflects an EV/bookings multiple of 6x our 2014 bookings estimate. We believe the relatively high multiple is warranted, as the risk of negative earnings or cash flow has been mitigated and bookings have begun to grow.